22 June 2022
Despite appearances of good health, GDP growth will weaken shortly and will not regain its strength before the end of the year. We expect GDP growth of just 3.5% in 2022 – that’s less than half of the 7.4% rise we enjoyed in 2021.
The final estimate of Q4 GDP came in at 1.3% quarter-on-quarter (q/q), slightly higher than the initial estimate of 1.1% q/q. That left the economy just 0.1% smaller than it was in the last quarter of 2019, before the pandemic. We are expecting growth of about 1% q/q in the first quarter of 2023, but growth is likely to slow sharply over the rest of this year as the cost-of-living crisis squeezes consumer spending.
Household disposable incomes set to shrink
The latest data show that consumer spending grew by just 0.5% q/q in 2021’s last quarter, revised down from the initial estimate of 1.2% q/q as the surge in omicron cases caused a sharp drop in transport spending. This sent consumer spending 1% below its pre-crisis level. What’s more, government spending growth was nudged down from 1.9% to 1.5% and net trade still subtracted 1.7ppts. The only factor that was revised higher was the contribution to growth from inventories.
What’s more, real household disposable incomes experienced their third consecutive decline and fell by 0.1% q/q. The surge in inflation, which will probably average around 7.5% this year, means that real household disposable incomes are projected to fall by a little over 2% in 2022. That puts them on track for their biggest drop on record.
Households to draw on savings
The decline in the savings rate from 7.5% in Q3 (revised down from 8.6%) to 6.8% shows households are responding to rising prices by starting to reduce how much they save.
Right now, household balance sheets are in a much stronger position than before the pandemic. Households paid off about £25bn of consumer credit and accrued excess savings of around £250bn during the pandemic, and the early evidence suggests that consumers are propping up their spending by borrowing more and saving less.
To put that savings amount into context, UK households spent about £32.4bn on electricity and gas in 2020, so a 50% rise would see them spending an extra £16bn. If households dip into their savings to counter rising prices, or the government acts to support households, then the impact on GDP growth may be smaller than we have assumed.
Middle market firms face an increasingly challenging outlook. The Russian invasion of Ukraine has dramatically increased the prices of a broad range of commodities, from oil to wheat, and that’s driving up costs. At the same time, consumers are experiencing the largest real income squeeze on record. This will inevitably impact demand, especially among lower-income consumers who will be hit hardest by rising energy and food prices. To top it all off, restrictions on exports from Russia and coronavirus-related shutdowns in China risk sparking another supply chain crisis before the economy has recovered from the last one.
While we aren’t forecasting a recession, we are expecting minimal GDP growth after Q1 and it would not take much by way of a further increase in energy prices or supply chain disruptions to push the UK into recession.